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Demutualization
Elections: Traps for the Unwary
May 8, 2000
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Thelen LLP
Many sponsoring employers and other fiduciaries of welfare
benefit plans are being offered the choice of approving or
disapproving programs offered by mutual (or member-owned)
insurance companies to convert the insurers to publicly held
corporations. This process, commonly called "demutualization,"
allows policyholders, including sponsoring employers, to receive
a distribution or allocation of stock or cash of the restructured
insurance company.
BEWARE! Behind the "yea" or "nay" vote regarding approval
of the demutualization program (as well as the choice to receive
cash or stock in the process) lurk legal landmines for the
unadvised. To make matters worse, demutualization programs
are being implemented without the benefit of any meaningful
official guidance from either the Department of Labor or the
Internal Revenue Service.
A sponsor of a contributory welfare benefit plan, for example,
tempted to accept a relative windfall on an insurance policy,
may find both the Department of Labor and the Internal Revenue
Service ready to pounce if a distribution is elected without
implementing the requisite fiduciary safeguards designed to
protect the interests of plan participants. If plan participants
have paid any portion of the premiums, that portion will be
considered a plan asset subject to ERISA requirements. Therefore,
unless the distribution is structured carefully, the employer
may be facing charges of plan asset reversion, prohibited
transactions and fiduciary breach, resulting in fines, penalties
and 100 percent excise taxes, not to mention possible negative
press and damaged employee relations. The income tax consequences
of a distribution under a demutualization program also should
be taken into account.
Each demutualization program must be reviewed carefully to
avoid the pitfalls briefly mentioned in this report. Documentation
of the reasons behind any decision to approve or disapprove
a demutualization program (and to elect cash or stock) is
essential to evidence fiduciary compliance under ERISA. Other
offered alternatives (such as policy credits or premium stabilization
reserves) should be considered. Employee communications are
critical in the process.
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For more information about the issues covered in this report, please contact David S. Foster in our San Francisco office at 415-369-7020 or at dsfoster@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2000 Thelen LLP
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